12/21/2020

Can Ethereum Be Replaced as the Blockchain for DeFi?

As seasoned users will know, the vast majority of the decentralized finance (DeFi) ecosystem is built on Ethereum, a blockchain also known as “the world’s computer.” Unlike its progenitor Bitcoin, the beauty of Ethereum is that it is fully programmable, allowing developers to design and build programs and protocols of all shapes and sizes onto it. 

This is why Ethereum has become the home of DeFi: a rapidly growing web of protocols that allows users to bank, save, trade and invest, and which has grown from a market of just $600 million in March 2020 to $32 billion as of 4 February 2021. This exponential growth, however, has put increasing pressure on the Ethereum blockchain, with congestion leading to sky-high fees to process transactions.

Known as gas fees, these charges to process trades on a DeFi protocol have risen from an average of $0.09 in February 2020 to an astonishing all-time high of $17.48 at the time of writing (4 February 2021). As we covered in a previous blog post, the implications of high gas fees for low capital users are pretty dire, making trades in the hundreds of dollars nowhere near as cost-effective as those in the thousands, and increasing user sensitivity to losses.

Source: ycharts.com

The long-touted Ethereum 2.0, will move the blockchain from a proof of work to a proof of stake model, effectively putting nodes and the right to run them up for auction, rather than requiring developers to mine them. Moreover, 2.0 will see the Ethereum chain split into 64 separate “shards” that will increase transactions per second to 100,000, up from the current 15 transactions per second, altogether making things much faster and smoother. 

The development of Ethereum 2.0 is rumbling on, with more than $4 billion staked on the network, and a hard fork expected in the new Beacon Chain coming in the middle of this year. This will be a “warmup” before sharding begins and Ethereum 1.0 and 2.0 are merged. As exciting as this is, it puts the full roll-out of Ethereum 2.0 toward the back end of 2021 at the earliest. 

Polkadot, the “Ethereum killer”

As Ethereum 2.0 is on cruising speed, however, DeFi is straining at the leash to grow and innovate, while gas fees are crippling developers and users alike. As such, there is growing interest in a number of new, “challenger blockchains'', or “Ethereum killers”, that are sidling up to be the new home of DeFi. Perhaps the most well-known among these is Polkadot, co-founded by Gavin Wood, Ethereum’s co-founder, who wrote the whitepaper for the new blockchain in 2016, not long after Ethereum went live in 2015. 

The key functionality of Polkadot are its “parachains” (short for “parallel blockchains”): a number of chains running together that make up Polkadot. Like Ethereum 2.0’s shards, these parachains are able to process transactions much faster than currently happens on Ethereum. Moreover, each parachain is able to integrate different functionalities, allowing for a diverse ecosystem of programs and protocols that are easily able to talk to each other - also known as “interoperability.”

These parachains include Moonbeam, the so-called “Ethereum on Polkadot” that allows smart contracts built for Ethereum to integrate easily onto the new blockchain. Moonbeam is proving to be a gateway for DeFi protocols, many of which are entering Polkadot through it. Protocols making the leap include cross-chain DeFi lending protocol Equilibrium, decentralized exchanges SushiSwap and IDEX, and leading Web-3 wallet MetaMask. 

Such is the bullishness around Polkadot that, since its launch in mid-August 2020, the value of its native coin DOT has risen from just under $3 to $21 as at the 4 February - a pump of 613% in six months. This is just under double the 329% spike seen in the price of Ether - Ethereum’s native coin - over the same timeframe. A recent announcement from Switzerland-based investment product provider 21Shares that it will soon launch an exchange-traded product (ETP) for Polkadot, has also provided a boost.

Avalanche hones-in on DeFi 

While less widely known than Polkadot, YIELD App partner Avalanche has potential to rival it as a new home for DeFi thanks to a laser focus on decentralized finance that allows “new financial primitives” to be launched on its chain. This is not least as, much like Polkadot, Avalanche is fully interoperable, allowing numerous other blockchains, platforms and protocols to operate on and work together on-chain. 

However, Avalanche claims to offer a much more decentralized model than either Ethereum 2.0 or the “Ethereum killers”. Unlike Ethereum’s new model of “sharding”, which aims to process transactions simultaneously rather than consecutively, Avalanche says it uses “consensus” as its model: the foundation of decentralized technology.

This means that applications will not have to compete for the same network resources to process transactions – which drives up dreaded gas fees – but instead each application on Avalanche can run its own independent blockchain that will be validated by custom validators known as subnets. While connected to the broader Avalanche chain, these subnets are not in competition with each other, but instead all add value to the network. Ultimately, this means that Avalanche can support 4,500+ transactions per second, scaling up to millions of full, block-producing validator nodes participating in consensus. 

This is all very technical, but it effectively means that Avalanche’s higher level of decentralization could make it a better fit for DeFi, which is why YIELD App has chosen to partner with it. The blockchain’s native token, AVAX, is also performing well, rising from $5.28 at launch on 22 September 2020 to $14.26 on 4 February - a spike of 170% in less than five months. 

Solana goes at lightning speed

Last but by no means least on our list of potential “Ethereum killers” is Solana, a chain that on 3 February made a big name for itself for being the first outside of Ethereum to mint fresh USDT: the US dollar-pegged stablecoin that underpins the entire DeFi ecosystem. Solana is particularly exciting thanks to its rapid speed, with developers claiming it can process up to 50,000 transactions per second.

Perhaps even more important for DeFi is that this rapid speed comes at a low cost: around $.00001, according to the firm’s homepage. This is, reportedly, made possible by Solana’s “Proof of History” consensus model that it says allows the network to scale at the speed of Moore’s law. Unlike Ethereum 2.0, Solana does not employ sharding, nor parachains, but instead a “high frequency, sequential validation system.”

This, combined with eight other innovations such as a mempool-less transaction forwarding protocol – what Solana calls the Gulf Stream - as well as parallel smart contract run-time (Sealevel), a horizontally scaled accounts database (Cloudbreak) and a distributed ledger store (Replicators) is what Solana says enables its speed. In addition, the high visibility that all of this is contingent upon is why Solana claims to be highly secure and “censorship resistant.”

The need for an alternative to chain to Ethereum to house the rapidly growing DeFi ecosystem has been apparent for at least a year, if not longer to some developers. However, with gas fees now making transactions unviable even for multi-million dollar platforms, that need has become urgent. Who will win in this arms race is not yet clear: or indeed it may be that a more evenly distributed network of interoperable blockchains is preferable. Only time will tell: although hopefully not too much more time.

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